We have reached the inevitable outcome of Richard Nixon’s, and later the rest of the world’s, decision to ditch the gold standard in favor of, well, hope that your counterparty is honorable.  The venerable Bank of England who, through the South Sea Bubble, the rise and fall of Napolean and Hitler, revolution in America and numerous other wars and recessions, had never reduced its benchmark rate below 2.0% finally blinked and reduced its rate to 1.5%.  The era of currency brinksmanship rages on. 

In their attempt to dig themselves out of the mess they created, the Japanese were the first to employ this weapon in our brave, new hope based world.  Their thinking, I guess, was that if they could cheapen their currency they could export their way out of their pending economic collapse and avoid the painful restructuring that their economy needed to go through after the bursting of their stock and real estate bubbles.  Implementing this theory has resulted in nearly two decades of Japanese economic stagnation and has had the side benefit of helping to destroy the American auto industry (while US management incompetence is surely the primary reason a cheap yen didn’t help).  For some reason, no one in America seemed to care about this blatant currency manipulation through 0% Japanese interest rates and let it go on.  The Chinese saw something that seemed great and decided to follow suit.  Why not grow your manufacturing sector through a cheap currency if the Americans are willing to sacrifice their own manufacturing sector and allow it? 

Unfortunately, all good things must come to an end and the credit induced boom where the Japanese and Chinese allowed the US to run up bigger and bigger deficits while those two countries maintained a weak currency and absorbed large portions of the world’s manufacturing capacity has come to an end.  Blame sub-prime borrowers, inept politicians, greedy bankers, or whoever else you would like, but, whatever the catalyst, the boom is over.

So, what are poor Ben Bernanke and Henry Paulson to do?  God forbid they allow the US economy to painfully restructure, let bankrupt companies fail and let the free market do its work.  No, they have chosen the path of bailouts and that distinctly Japanese weapon: currency manipulation.

You shall not crucify mankind upon this cross of gold, indeed.  Why pay your debts back when you can simply inflate them away?  It is so easy.  You just turn on the printing presses a little at a time and, voila, at some point your debts have become manageable.  Nothing could be easier. 

The problem with the inflate away your debts philosophy, besides being a dishonorable and shameless thing to do, is that at some point the suckers in the game, foreign holders of your debt and currency, realize what you are doing and are forced to react.  They can react the way people have done throughout time, refusing payments in your currency and demanding gold, or they can engage you in your game of brinksmanship and crank up the printing presses in their own countries.  The later seems to be the path du jour.

What happens when every country in the world prints money with reckless abandon in an attempt to maintain the value of their dollar holdings in terms of their local currencies while at the same time avoiding a rapid strengthening of their own currencies and the resulting havoc in their manufacturing sectors?  Who knows?  This is one big experiment and now that even Mervyn King has bowed to the pressure and the Bank of England has joined the game in earnest, I guess the world will find out.